As of late Wednesday bulls and bears can take their pick from a wide menu of opinions. Bulls say a vaccine is coming and the curve is flattening. Bears point to record Fed and government packages that carry a huge cost. The bears, like Jeff Gundlach and Howard Marks, come from the bond market side. Naturally, they see much more selling and unprecedented intervention to stabilize markets. The bulls, like Larry Fink and Jeremy Siegel, look more at health issues and their impact on equity prices. We think that Jeff and Howard are the realists and there is more bad news that is coming that is not in current prices.
The Virus and Oil
COVID-19 and the simultaneous OPEC oil collapse created massive instantaneous uncertainty and a raging bear market. Two weeks ago we wrote about the typical anatomy of a bear market. We believe we are in Phase 2 where rallies can be enticing for those desperately searching for a bottom. You will continue to see daily reminders along the lines of “buy when there is fear”. We know from past experiences that bear market bottoms are not found in one day, one week, or even one month.
All bear markets over the past 40 years have included bear market rallies. Phase 3 comes when another wave of bad news and market despair overtakes investor confidence. The real bad news must be published and digested to move forward. We wrote about what the wave of bad news might look like in last week’s article, Buying Signs In An Uncertain World.
Major banks are forecasting a lightning-fast recovery in the 2nd half of the year. Some call it a V or a U shaped recovery. I even saw reference to a Nike ‘swoosh’ shaped recovery. Goldman forecasts a -24% drop in GDP in Q2 followed by +12% and +10% in Q3 and Q4. GDP tends to move in the low single digits, up 2% to 4% in a given year is positive. We don’t see a swift recovery with 30% unemployment when most people have no savings and tens of thousands of small businesses are permanently closing. At this point in time, we don’t know when our new normal will set in. When is the next time we’ll see a crowded stadium? Probably not before body temperature cameras are installed in all major airports and venues. As Dr. Fauci says, “the virus sets the timeline”.
Furthermore, this event has caused an unprecedented supply and demand shock to the global economy and has forced a major change in life at home and at work. The US is considering bringing its manufacturing back home, especially drug manufacturing. Work from home will almost certainly be more common going forward. The Fed and Treasury have reacted to COVID-19 with equally unprecedented action. However, their stimulus mostly supports liquidity in the financial system with some small business support. The Standard and Poors Global Report says, “the translation from health outcomes to economic variables remains highly uncertain”.
More Stimulus Needed
Nancy Pelosi is already talking about a second 2020 stimulus bill, aimed this time at state governments rather than the consumer. Since it is an election year, a ‘vote by mail’ clause, costly to states, is surely going to be included by Democrats. President Trump opposes it. As for the size of the stimulus, the same $2.2 trillion number is under consideration. Anything less than that will likely be a disappointment to the markets. Right now, Congress is scheduled to reconvene on April 20th. We expect this second stimulus bill to be passed in May. The subject of who pays for all the stimulus has been debated ad nauseum. So far the debt markets have broadly accepted the fiscal stimulus bill. If the debt markets balk at any part of this second package though, expect equity prices to plunge.
Too Fast For The News Cycle
There have been no hedge fund blow ups or Ponzi schemes uncovered. Warren Buffett is quiet and has not announced any new major acquisitions. We haven’t shut down the markets for more than 15 minutes at a time. We know that hotels, airlines and movie theaters, among many others, have experienced a 95%+ reduction in revenue, yet we haven’t seen the official earnings releases. As Charlie Munger says, “the big money is not in the buying and the selling, but in the waiting”. That advice holds true for significant holders of cash and for fully invested holders of stock.
Consequences of An Endless Rescue
We all know how long it took to get out of the 2009 fiscal rescue – much longer than we all expected. Short term rates were at zero for ten years. Companies that would or should have failed did not, and we are still dealing with that in 2020. Even now the US government owns big and essential formerly public companies like Fannie Mae and Freddie Mac. The 2009 bailout plan led to three rounds of quantitative easing, which was not part of the original rescue plan. The Fed balance sheet more than doubled.
Now we have a new rescue plan, the $2.2 trillion CARES act. We can combine the old rescue plan of 2009 plus a new rescue plan that is already scheduled to get larger. A third rescue plan is likely. If you want to know what unlimited Fed support looks like, look to Japan.
Regular rescue plans are one more reason to be skeptical of current stock market prices. The Fed can print money in the short term but over the long term real wealth is not created by printing money. Proverbially kicking the can down the road prohibits markets from finding the very bottom needed to start a new cycle and create wealth. That is how capitalism survives.
Each day during the pandemic has felt like a month and many questions remain. It’s unclear how COVID will develop in major countries like India where city populations are dense. By Summer we may have a massive infrastructure bill that will provide work and income for millions. We will find out.
In the meantime, we have been readying buy lists and sell lists for each client based on their individual situations. We are aided significantly by our Essential-Important-Discretionary approach to money management. We consider all possible economic outcomes when making investment decisions and our clients rely on us to act with prudence. Please reach out if you would like to discuss how we are navigating clients through this market and onto the next stage.
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